Tuesday’s Stock Option Trading Strategy!

November 27, 2007
Author: Peter Stolcers, Founder of OneOption

Yesterday, the market tried to add to Friday's light volume rally. The market started off on a positive note but that quickly gave way to selling pressure. By the end of the day, the market was in a full-blown sell off. We are officially in correction territory since the market is down more than 10% from its peak value a month ago. In the chart you can see the technical damage. The double top formation, the trend line breach and the breakdown below horizontal support are all negative developments. The bears have the ball and fear is driving this market. Each time the market tries to stage a rally, the sellers step back and wait for the move to lose its momentum. By early afternoon, they are aggressively shorting the market. Many bulls are also running scared and they are selling their holdings as well. Yesterday, the selling started early and the bears were anxious to dump shares after last Friday's bounce. This morning, news that the Abu Dhabi government was investing in Citigroup helped support financial stocks. While this might seem like a positive development, that capital was attained in a relatively stiff price. After an initial pop, the market is trying to hold on to the gains. The stocks of, commodity producers, heavy equipment manufacturers, and infrastructure/construction companies are under pressure now that recession worries have surfaced. These stocks were leading the market rally and now they have "rolled over". The market has lost its leadership. Tomorrow, the durable goods orders and the Beige Book will reveal economic strength or weakness. The Fed has already indicated that they are reluctant to cut rates any further. Inflation is on the rise in the dollar continues to get crushed. Any additional easing by the Fed would add to this problem. The economy will have to work itself out of this mess. If the economic numbers come out better than expected, there is a chance that the bleeding will stop temporarily. It is quite possible that traders will let the market rally and then sell into it on the notion that these numbers are backwards looking. On the flip side, weak numbers would confirm that we are headed for economic trouble. If that happens, we are headed lower, no questions asked. I feel there is a greater chance for a pullback than a rally tomorrow. The market is already established a wide range today. Yesterday’s sell off was very deep and there is a good chance for a nice rebound today. However, I would not buy into this rally. If the market rallies early tomorrow on the durable goods number, I would look for shorting opportunities. The Beige Book is somewhat of a sleeper since it is released in the afternoon. It could be a catalyst for a late round of afternoon selling. There are a couple of positives in the market. We have seen a 10% correction from the high and we are headed into end-of-the-month bullishness. Apart from those two factors, I see the odds currently stacked in the bear’s favor. I still feel that we need to see a huge sell off and an intraday reversal before I can take confidence in a temporary support level. That short-term support level might be found at SPY 137. I feel the worst case scenario for the next few months is a drop to SPY 125. That was a breakout level in October of 2005 and it represents a 20% decline from the high. image

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